A. Explain why the reward-to-risk ratio must be equal for all securities if the financial markets are efficient (law of one price).
B. Draw the following three graphs: First, you need to plot the value of the firm on the vertical axis and the total debt on the horizontal axis. Use this graph to illustrate the value of a firm under
1) M&M without taxes
2) M&M with taxes, and
3) the static theory of capital structure (with M&M with taxes and bankruptcy costs).
Briefly explain in words what these three graphs reveal about the capital structure